Stable Capital Market Necessitates Short Mechanism
On September 4, SEC filed a lawsuit against CSKI headquartered at Harbin and Yen-Chin Liu, chairman and CEO of CSKI for the falsely fattened sales incomes and the major financial data frauds.
This affixed a vivid footnote to such a war of words across the Pacific: Also on September 4, more than 60 Chinese senior managers, investors and entrepreneurs spearheaded by Kai-Fu Lee, chairman and CEO of Innovation Works, jointly signed an open letter, attacking the western short-selling institutions headed by Citron Research focusing on the Chinese market and accusing them of targeting at the Chinese law-abiding companies which have no or small problems particularly by fabricating information and drafting the false reports as the American readers fail to find the rational way to verify the authenticity of such information. However, Citron Research strongly stood up against the accusation by giving the positive response to the questions raised by Kai-Fu Lee on its website.
Short Mechanism is a very common practice on the securities market. However, why do we need the short mechanism? Here is a simple reason for it: In the market lacking the short mechanism, if an investor predicts that the price of the stock is about to drop, the only rational practice for him is to sell off the corresponding stocks and take a short position and patiently wait. Where the short mechanism is available in the market, the investor may operate the stock the same way he operates the futures: on the one hand, the investor may apply the short mechanism to hedge against their capital, reduce the investment risks and increase the capital security; on the other hand, the investor may “take his initiative to act”, thus obtaining the likely benefits due to the drop of the stock price.
Thanks to the availability of the short mechanism, those companies engaged in the investigation of the false information of listed companies have the commercial value. In a market void of the short mechanism, what the intermediaries can do is “to make it much better” and continues to “discover” the positive news of listed companies so as to obtain the benefits from the stock price rise. However, the short mechanism means that you can obtain benefits by investigating the false information of listed companies. Besides, the co-existence of the long mechanism and the short mechanism can contribute to the market for the overall judgment over the basic information of the listed companies to achieve the market clearing and conduce to the protection of the investors’ interests.
Just for these reasons, the current mainstream stock markets, say, the New York, Hong Kong, London and Singapore markets have the readily available short mechanism. Notwithstanding that, how come that Kai-Fu Lee and his allies took a stand against those institutions following the short mechanism? We can observe and find that the famous persons jointly signing the open letter, particularly including the winners in the capital markets, are sure to have known the role played by the short mechanism in the modern capital market. Yet, why do they impose a very serious accusation on such market intermediaries like Citron Research? Or is it as true as Citron Research claimed that Kai-Fu Lee and these companies do have the material interest relationship?
It is necessary for us to reinterpret the open letter signed and issued by Kai-Fu Lee who pointed out in the article entitled “Institutions short-selling the Chinese stocks: exposing the fraudulent actions or practicing fraud”, the survey reports issued by Citron Research couldn’t hold water with so many loopholes as it lacked the basic understanding of China’s Internet and Search Engine Market but deceived investors to gain higher profits by fabricating and distorting the information, and also doubted whether the institutions having short-sold the China-based stocks cracked down on fake information or just cooked up rumors in the market. Or in other words, Kai-Fu Lee actually accused Citron Research of not professionally engaged in the short-selling, which might be kind of a fraud itself.
If the accusation of Kai-Fu Lee proves to be true and the information is not professionally disclosed by Citron Research, which may be involved with fraud, how can the investors do in such a case?
In essence, we don’t need to worry about whether the information provided by the market intermediaries are true or not, or we didn’t event care about whether they engaged in the fraudulent practice in the name of the information disclosure. However, a vital realistic restraint is that the credit is the most important asset for all intermediaries in the securities market. If the reports prepared by an institution prove to be repeatedly futile and unreliable with the “cry wolf” effect, our investor will not trust their report any more. As a matter of course, the short mechanism practiced by these institutions will fall flat. From this perspective, the argument of Kai-Fu Lee and his allies of accusing of information asymmetry maneuvered by Citron Research and the similar intermediaries does not hold true.
What a lesson can we draw on from the war of words across the Pacific to benefit the Chinese securities market? In my opinion, a very important enlightenment is that the crack-down on the false information can become a profitable business, and only so, the stock market can achieve the positive cycle other than the bad money driving out good money. As we know, if the stock market lacks the short mechanism, there won’t be institutions like Citron Research – who will engage in business that can only harm others but gain no benefits? The consequence is that a drinking-game is merrily played among all of us to increase the cost in identifying the poor-performing stocks and at the same time jeopardize the interests of investors.
Most importantly, as for a promising market like China, it is more efficient to discover the poor-performing listed companies than the initiative law enforcement by the supervisory authority, thus having saved the supervision cost. On the one hand, the information disclosed in the market does leave much to be desired, but on the other hand, the supervisory authorities fail to screen and verify the information due to the lack of enough working staff. If China’s stock market does have the short mechanism, there will be more companies quite similar to Citron Research to identify and verify the authenticity of the information available in the market, so the capital market will have the sound development, or let me put it this way, a lot of the active market intermediaries can virtually save much supervision cost and can, to some extent, weaken the rent-seeking space of the supervisory authorities.
The war of words between Kai-Fu Lee and Citron Research can positively contribute to the full understanding of the short mechanism on the part of the public in China and it really hits the spot for the sagging stock market in China.
Originally published on Oriental Morning Post | 2012-9-13
